Thread by @FinsenseG

Thread: Asset Liability Management (ALM)

This is the buzz word in our stock market since the DHFL fiasco happened. Everybody in the market learnt a new keyword: ALM aka Asset Liability Management. Let's understand the concept of ALM in detail.

ALM can be defined as a comprehensive management of assets and liabilities.

What are Assets for the banks?
The loans given by banks to its customers.

What are Liabilities for the banks?
The deposits received by bank in form of FD and the money raised by issuing bonds and NCD's in the market.

Now these assets and liabilities are nothing but the future cash inflows (assets) and future cash outflows (liabilities).

In the ALM mechanism, the banks have to group these assets and liabilities in the time slots of the duration. Assets in these time slots are to be matched with liabilities in the corresponding time slot. Any differences, whether positive or negative are called Mismatches.

After the deregulation of interest rates, Banks were given freedom to manage their balance sheets, hence ALM guidelines were introduced to ensure the banks can be prevented from huge asset liability mismatches which may lead to huge losses.

After the deregulation of interest rates, Banks were given freedom to manage their balance sheets, hence ALM guidelines were introduced to ensure the banks can be prevented from huge asset liability mismatches which may lead to huge losses.

Also the desired maturity profile of the incremental assets and liabilities in addition to monitoring the risk levels of the bank is fixed by ALCO. It will have to articulate current interest rates view of the bank and base its decisions for future business strategy on this view.

Let us now try to understand the various techniques employed by banks for management of Assets and Liabilities:

1) Gap Analysis: This method is used to asses the Interest rate risk or liquidity risk on the Rate sensitive assets (RSA) and Rate sensitive liabilities (RSL).

These RSA and RSL are basically the floating interest rate loans or deposits and also the instruments which have premature withdrawal or repayment option.

GAP is basically the difference between RSA & RSL (GAP = RSA-RSL). The mismatch can be positive or neagtive.

Positive (Asset>Liability): The bank can deploy the excess of flows from assets in money market or create new assets.

Negative (Liability>Asset): The bank can finance by borrowing from various sources (money market, Repos etc).

2) Duration Analysis: Check how the duration of an instrument can affect the stream of cash flows with interest rates changes in our previous thread:

https://twitter.com/FinsenseG/status/1258018138924310530

.

Longer the duration, Higher the sensitivity of instrument/loan to the interest rate changes.

It doesn't causes trouble when the assets and liabilities are priced at fixed rates however the complex instruments like callable debt posed problems that gap analysis could not address. It sounds easy in theory but is sophisticated when applied in practice.

3) Scenario Analysis: In this analysis, a simulation is done on various scenarios which might occur in future and affect the ALM. This includes checking the impact on ALM due to scenarios like declining interest rates, rising interests rates, a gradual decrease in rates followed

by sudden rise etc. Further the assumptions are made relating to factors like prepayment rates on mortgages etc. If the projected performance is poor under a particular scenario then ALCO might adjust the Assets or Liabilities to address the indicated exposure.

Conclusion: ALM is an important tool to manage and monitor risk. A bank having strong ALCO can instill huge confidence in shareholders and can survive and propel it's business.

Here is a snapshot of how ALM calculation looks like:
Source: Bajaj Finserve Presentation

Tip:
1) Read ALM & ALCO section of NBFC's/Bank's in Annual Report.
2) Check investors presentation of companies to find this data.

by @RJGyanchandani & @adi2five

@threadreaderapp unroll